How Will the Secure Act 2.0 Affect Your Retirement? - Episode 51
Yes, there’s been another big tax law change. As I like to say, our tax law is written in pencil and it can change quite often.
In the past few years, we have seen several changes related to retirement tax planning including:
- The Tax Cut and Jobs Act, passed in late 2017
- The SECURE Act, passed in late 2019
- And now the SECURE Act 2.0, passed in late 2022
The SECURE Act 2.0 is part of a much larger spending bill called the Consolidated Appropriations Act of 2023.
There’s A LOT to unpack in the new laws, but I will hit on some highlights here.
Listen to Episode 51 Here:
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First, I want to let all of our clients know that you do not need to do anything immediately, and we will help you with any changes we need to make as a result of the SECURE Act 2.0.
What is Included in SECURE Act 2.0?
Here is a brief overview of some of the changes included in SECURE 2.0:
- An increase in the RMD age (again!)
- Reduced penalties for missed RMDs
- Removing RMDs from employer-sponsored Roth retirement plans
- Employer contributions to Roth retirement plans
- Ability to roll unused 529 plan funds to a Roth IRA (with restrictions)
I will unpack each of these topics in this episode.
Increase in the RMD Age
The Required Minimum Distribution (RMD) age is increasing again!
RMDs are required to be taken from traditional IRAs and employer-sponsored retirement plans to keep those accounts from growing indefinitely. And, of course, because the IRS wants their share of that partnership money because it is pre-tax money. (I like to remind clients that when you have a pre-tax account, you have a silent partner in the IRS, and they are always going to get their cut.)
For years, RMDs were set to begin at age 70½. Then that age increased to 72 in 2020 with the SECURE Act.
Now, effective January 1, 2023, the RMD age has increased based on the year you were born.
- The RMD age remains 72 for those born in 1950 or before.
- Those born from 1951 and 1959 will have an RMD age of 73.
- Those born in 1960 and later will have an RMD age of 75.
If you're turning 72 in 2023, you will not be required to start your RMDs until 2024 at age 73. (Inherited accounts are different and have their own RMD rules.)
But those who have been required to take RMDs prior to 2023 are still required to do so in 2023.
What does this change mean for investors? This gives you more time to convert tax deferred money to tax free money with Roth conversions before those required distributions begin. This also gives you more control over when and how much you pay in income taxes.
Reduced Penalties for Missed RMDs
Previously, if you calculated your RMDs incorrectly or simply forgot to take them, you suffered a 50% tax penalty on the shortfall (plus interest!). That penalty has now been reduced to 25% starting in 2023.
However, if you correct the past-due RMD and pay the taxes on it within two years, the penalty drops to 10%.
While I don’t recommend missing an RMD, this reduction in penalties will help soften the blow if it does happen.
Removing RMDs for Employer-sponsored Roth Retirement Plans
Roth IRAs are not subject to RMDs for the account owner.
However, Roth 401(k) and Roth 403(b) accounts have been subject to RMDs as employer-sponsored retirement plans.
Beginning in 2024, RMDs will no longer be required from employer-sponsored Roth retirement plans, including Roth 401(k)s and Roth 403(b)s.
This change aligns the rules for employer-sponsored Roth retirement plans with the rules for individual Roth IRAs.
And this will benefit those who have already started RMDs and those who have not yet reached RMD age.
This is a delayed change, so RMDs are still required from these employer-sponsored Roth plans in 2023.
Employer Contributions to Roth Retirement Plans
Starting in 2023, employers can offer workers the choice to receive vested matching contributions and non-elective contributions directly to the Roth side of their retirement plan, where they’ll grow tax-free.
Previously, the employer’s matching contributions would be deposited into the tax-deferred side of employer-sponsored retirement plans, even if the employee contributed after-tax money to the Roth side of the plan.
Also, Roth contributions to SIMPLE and SEP IRAs are authorized in 2023. Previously, SIMPLE and SEP IRAs could only include pre-tax funds.
The participants will have to pay the income tax on the employer’s Roth contributions, so this is definitely something to keep in mind when it comes to taxes and withholdings.
However, we’ll have to wait for the IRS, employers, account custodians, and plan administrators to work out procedures before people can fully take advantage of these new opportunities.
Roll Unused 529 Plan Funds to a Roth IRA
Parents and grandparents have worried about saving too much money in 529 education saving plans since the accounts have been so limited. Soon these accounts will have a Plan B.
There are still plenty of restrictions, but 529 plan beneficiaries will be able to roll over money from a 529 plan into a Roth IRA.
So, if your child ends up receiving scholarships or not needing all of the money in their 529 account, there is an additional option to use the remaining funds.
Note, there are a lot of requirements that must be met including:
- The Roth IRA account must be in the name of the 529 plan beneficiary
- The 529 plan must have been open for at least 15 years
- Account holders can't roll over contributions (or earnings) made in the last 5 years
- There is a maximum of $35,000 that can be rolled over, and there are annual limits for rollovers based on the annual Roth IRA contribution limit
This is different from a Roth conversion from a traditional IRA. A typical Roth conversion has no effect on an investor contributing to a Roth IRA in the same year.
But the way it’s worded, this rollover from a 529 plan to a Roth IRA will count toward the recipient’s Roth contributions for the year.
This option doesn’t go into effect until 2024, but it will be interesting when this alternative becomes available.
What Didn’t Change with SECURE 2.0?
1. Roth IRA Conversions
This was something that was talked about during the year, but no changes were made to Roth conversions or backdoor Roth IRAs. These can still be completed as they have been in the past.
I talked about Roth conversions and backdoor Roth IRAs in Episode 8.
2. Qualified Charitable Distributions
Neither the SECURE Act nor SECURE Act 2.0 affected the age at which Qualified Charitable Distributions (QCDs) can be made from an IRA to a charity. Individuals can still make QCDs starting at age 70.5.
QCDs are beneficial because you can have a specified amount paid from your IRA directly to a charity of choice, and that amount will be excluded from your taxable income for the year. The QCD can also be used to meet your RMD for the year.
Bottom Line:
As we’ve learned with previous new regulations, Congress might enact new laws, but we often have to wait for the IRS and other agencies to catch up before we can fully make use of them.
Sources:
https://www.kitces.com/blog/secure-act-2-omnibus-2022-hr-2954-rmd-75-529-roth-rollover-increase-qcd-student-loan-match/
https://retirementstartstodayradio.com/breaking-news-secure-act-2-0-ep-279/
https://podcasts.apple.com/us/podcast/retirement-tax-services-podcast/id1566871455?i=1000594615185
Related blog posts:
https://erwealth.com/podcastblog/tax-planning-for-the-charitably-inclined
https://erwealth.com/podcastblog/reducing-taxes-using-roth-ira-conversions
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